Flexible Leases Share Risks & Profits

Flexible Leases Share Risks & Profits

Both farmers and landlords are showing more interest in flexible cropland leases for 2012, as an alternative to fixed amount cash rent leases.

Iowa State University Extension farm management field specialists are holding over 50 meetings across Iowa in July and August addressing the topic of cropland rent and leasing agreements for 2012. They are getting more interest in and questions about flexible cash leases, as an alternative to paying a fixed amount of cash rent per acre.

The following information about flexible leases comes from William Edwards, Iowa State University Extension farm management specialist.

Uncertainty about what is a "normal" price for corn and soybeans, plus fluctuating seed and fertilizer costs, have made it increasingly difficult to estimate what is a "fair" cash rent for Iowa farmland. Moreover, the September 1 deadline in Iowa for terminating leases means that many rents are set or renewed for next year before the current year's crop is harvested. This past year clearly showed that a lot can happen after September 1.

Flexible cash leases replace a fixed rental rate with a formula for setting the rent based on actual prices and yields each year. Flexible leases have been around a long time, but have been gradually gaining acceptance. A recent ISU survey estimated that about 12% of the cash lease contracts in Iowa had some type of flexible provisions.

Consider pros and cons of flexible cash rent leases

Flexible leases have two major advantages: The amount of rent paid each year rises or falls with the profitability of the crops produced, and the need to renegotiate a cash rent that is acceptable to both parties each year is eliminated. On the other hand, flexible lease are more complicated than fixed rent leases, and the two parties must agree initially on how to determine the yield and price values that are used to set the rent. Moreover, some owners are not in a position to assume more risk and prefer a fixed return on their land investment.

Although some flexible leases set the rent based on variations in yield or price only, most contracts include both of these variables. The most common type calls for the owner to receive cash rent equal to a specified share of the gross value of the crop.

The value of the crop is determined by multiplying the actual harvested yield, after drying, by the market price available to the tenant. This type of lease shares both price and yield risk between the owner and tenant, similar to a crop share lease, but the owner does not have to pay any expenses or market any grain.

Determining the yield and price is very important

It is important to agree ahead of time on the procedure for determining the prices and yields that will be used to calculate the final rent. Actual yields can be determined by sales tickets or bin measurements. Many parties simply agree to use the same values submitted for crop insurance verification. A few flexible agreements use the county average yield instead of the farm yield. This eliminates the need for production records, but exposes the tenant to the risk of an isolated weather event. Plus, official county yields are usually not available until February.

The price used to calculate the final rent can be the cash price at a nearby elevator or processor at a certain date, or an average of the prices on a series of dates. Traditionally, the dates selected have been during the harvest season. However, many tenants begin pricing their crops up to a year before harvest by using forward contracts or futures contracts.

More and more flexible leases are using prices available starting well in advance of harvest, which may be a more accurate estimate of the selling prices received. Prices available after harvest reflect gains from storage and probably should not be used unless the owner is providing storage facilities as part of the lease agreement.

Other pricing options include using USDA's posted county price on specified dates, and using futures prices. If futures prices are used, both parties should agree on a basis value to be subtracted to reflect a local cash price.

A variation of the flexible lease is to use "bonus rents"

A variation of the flexible lease described above is to set a base rent and a base-gross revenue, then calculate a rent "bonus" equal to a percent of any gross revenue above the base value.

The base revenue may be an average of the gross revenue received on the land in recent years, or it can be set equal to the tenant's cost of production, including the base rent value.

Setting base revenue equal to the cost of production helps protect the tenant from unexpected increases in input costs, such as for fertilizer and seed. However, it also introduces another element of communication between the owner and the tenant.

The base rent can be an average of the rent charged in recent years or simply the minimum rent the owner is willing to accept. In either case, it should be reasonable compared to the base revenue figure used.

What about USDA payments and crop insurance payments?

In the past, USDA commodity program payments have been an important part of crop revenue, but direct payments are the only ones still being received on many farms. Since the direct payments are tied to the land, it is justifiable to include them in the estimate of gross revenue used to determine the rent.

Payments from the ACRE and SURE programs could be included, too, but they are not determined until a year after the crop is harvested.

The Farm Service Agency will now continue to pay all commodity payments to the tenant operator, even if the cash rent lease has flexible provisions.

Crop insurance payments also make up a portion of the revenue derived from the crop in some years. If insurance payments received are included in the gross revenue used to calculate the rent, then the premium paid by the tenant should be subtracted, even in years when no indemnity payments are included. This allows the owner to indirectly "insure" the rent, but also pay a percentage of the cost. However, if a base revenue value equal to the tenant's cost of production is used, and crop insurance premiums are already included in that total, they should not be subtracted again.

Owners and tenants need to discuss the provisions

Owners and tenants need to discuss the various provisions of a flexible cash lease, put them in writing and work through a couple of examples so that everyone understands how the final rent will be determined. A well-constructed lease will then adapt automatically to changing yields and prices in the future.

More information on flexible cash rents can be found on the ISU Ag Decision Maker site. Go to www.extension.iastate.edu/agdm/ and look under "Leasing."  An electronic spreadsheet for testing flexible lease terms is also available at that site.

For farm management information and analysis, go to ISU's Ag Decision Maker site www.extension.iastate.edu/agdm and ISU Extension farm management specialist Steve Johnson's site www.extension.iastate.edu/polk/farmmanagement.htm.

Hide comments

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Publish